Monday, October 01, 2007



I know a lot of people believe that all taxes are bad. In truth, taxes are not evil but instead they are a valuable tool. A tool that is hard to use properly but, still, just a tool. People join together for their common defense, domestic tranquility and other good reasons. Agreeing to share the cost of services that could not be afforded individually is a good idea. Over the next 48 days, the congress will do battle with the President and they will eventually reach a "good compromise tax law". It will not be a perfect tax law. It will raise the tax on carbon fuels and lower other taxes. If the two revenues streams are offset well, this will be a very good tax law.

Under current tax law, 20 million Americans are about to be hit with a bad tax. It is called the Alternative Minimum Tax. What this tax does is take away many of the tax deductions enjoyed by most Americans; tax deductions for charitable giving or for home interest expenses. The tax hits the "upper middle class income earners". The AMT essentially converts the income tax to a flat tax for these folk. They pay 28% on all income above $175,000 and 26% of income on all below $175,000 and receive the standard deduction of the first $62,550 for married couples ($42,500 for singles). In reality, most of this group has not paid the alternative minimum tax because each year the congress has been kind enough to provide a "patch". To reduce the number caught by the AMT from 20 million to 4 million tax payers in 2007, the congress would need to pass a patch that would "cost" 50 Billion Dollars. The size of the patch needed is growing each year. Over the next 10 years, it would cost One Trillion Dollars to "fix the AMT". In 1999, the republican congress passed a bill to abolish the AMT but the bill was vetoed by President Clinton. Current congressional leaders, including Charlie Rangle, have made "fixing the AMT" a priority. How can it be done without recking the budget?


President Clinton proposed a carbon tax but it went nowhere. Now, there are two major carbon tax bills floating through the powerful House Ways and Means Committee, where all tax bills must originate and there is also a bill being prepared by John Dingle, Chair of the powerful commerce committee. President Bush held an environment conference last week where he stated that the US will do its share to lower carbon emissions but that he is not willing to wreck the economy to accomplish the task.

The good news is that there is a "WIN, WIN, WIN" alternative available. Yes, a new carbon tax paired with other equivalent amounts of tax reductions would lower carbon emissions, start out with no net increase in taxes and allow consumers and businesses to gradually find ways to cut their total tax bill. By paring the carbon tax with lower marginal income tax rates, the net to the economy would be stimulative, creating new jobs and higher net incomes. It would make great sense to invest in alternative energy projects if those projects became profitable as a result of higher cost to carbon fuel systems.

It is pretty amazing that a consensus is building around these Pigouvian taxes. Arther Pigou must be doing back flips from his grave. It has been a hundred years or more since Pigou presented us with the good common sense point of view that if you need to raise revenue through taxes, it makes sense to tax something you want to discourage; governments that tax pollution raise revenue and cut down the amount of pollution, killing two birds with one stone.

While the exact level of the taxes to be assessed must be hammered out, the real tough nut to crack is in regard with what to do with the revenues. Again, President Bush held his global warming conference just last week for a good reason, he has pledged to veto any legislation that would use the carbon tax revenues as part of a "tax and spend program". Here again there is good news; there is no need to subsidize mass transit or alternative energy if the tax on carbon is set at the appropriate levels.


It is a fact that the burning of fossil fuels includes externalities that are not captured in the price. In other words, if you decided to heat your home with a coal or a wood stove, your neighbors would smell the smoke and consume the fumes. Pollution control laws have helped but there is world wide agreement that more should be done to reduce CO2 emissions. Very complex "cap and trade" proposals are not the answer. These have been proposed and even implemented in some countries. They have not worked well. If a cap and trade system were well constructed and well run, the effects would be exactly the same as a carbon tax but when not done correctly the results are waste and even corruption. Cap and trade systems often result in corporate welfare to the worst of the polluters and to huge campaign funding sources for the parties in power.

By placing a carbon tax on carbon when burned, the effective price of coal will be increased substantially more than the price of natural gas, which is a relatively clean burning hydro carbon. The Dingle proposal would include a new tax on gasoline with the revenues from that specific tax being added to the US Highway Trust Fund.

One of the main reasons that the carbon tax is the preferred method of reducing carbon emissions is that multiple incentives are passed out by the invisible hand of Adam Smith, yes, the free market gets to decide which fuels will be used. Wind mills that generally make no real economic sense, would be more competitive once a tax has been added to the burning of fuels. The same would be true of solar energy. At current prices, solar cells are not much more than a grand lab experiment. Solar cells are hundreds of times more efficient than just 10 years ago but they are still an expensive alternative in most situations. Add a fairly priced carbon tax to the burning of fuels and once again, the day when solar panels make economic sense jumps forward.

People should not be forced to take mass transportation. They should be offered the choice in situations where it makes economic sense. Mass transit is an efficient way to move large numbers of people. Raise the tax on fuels and break even points for mass transit systems will be lowered. Many a system that is currently operated only because government subsidies are provided, might actually become worth while ventures. Efficient free enterprise systems would also receive a nice boost; for example, airlines that haul hundreds of people for much less fuel per mile than cars or smaller planes would see an increase in the cost of fuel but much less per passenger than the increase in individual transportation costs. Many a 200 or 300 mile road trip would be replaced by the more fuel efficient airplane hop.


Al Gore proposed that a carbon tax be passed with the offsets being to the payroll tax. There is great logic in the idea of increasing the taxes on excessive carbon and decreasing the taxes on labor. I give Big Al credit for a good plan but not the best. Greg Mankiw, an economics professor at Harvard, deserves credit for promoting Pigouvian taxes for many years. I am not sure how he would offset the revenues but I am certain that he believes strongly that the revenues should be offset. Art Laffer is my champion. The Laffer curve does work. The logic of the Laffer curve is simple enough. It is only common sense that there is an optimum level of taxation. To prove the point, consider the extremes. If government were to charge taxes equal to 100% of revenues, there would be no reason for companies or individuals to make money and the government would receive no income. On the other hand, if the government were to charge zero in taxes, the government would receive no income. Taxes work just like the price of a good. A business can set its price too high, too low or, if lucky, just right. At just the right price, the company will make the most profit. At too low a price, the company will sell more units but the profit per unit will be small; at high a price the profit per unit will be high but the drop off in the number of units sold will be larger than the gain from the higher price.

At the current time, US tax revenues are TOO HIGH! As best as I can remember, it is Ed Yardeni who has worked through the numbers to show that the US deficit is currently not at the "efficient frontier" but it is too low. One really does not need to study a long mathematical proof to understand that US taxes are too high. One can simply look at what is going on in the market place. Between 1982 and 1999, the average corporate tax fell from 46% to 33% while revenues grew. Clearly the optimum level of corporate taxes was not 46%. In the past 5 years, 16 European Nations have lowered corporate taxes. Today, the US corporate rate is 40% while the average European rate is 24%. Is it any wonder that jobs and investments are flowing over seas? Is it any wonder that the Euro has climbed about 60% in value during these years (or that the US dollar has fallen 60% during this time)?


Because we are at a critical and major "turning point", I have been writing some long emails. I thank you for wading through. I hope you will take advantage of the situation and add what you can to your investment accounts. The following summary includes a couple more of the "good things about the coming carbon taxes".


The total tax combination of 10 cents per gallon each year for 5 years in a row plus a tax of $50 per ton of carbon would be 63 cents per gallon at the end of the 5 years.

The cost to the consumer would be less than 63 cents; Saudi Arabia would likely see less demand and thus be forced to lower prices to less than they would have been without the tax.

The total true cost of high carbon fuels, such as coal, would be more fairly captured.

INCENTIVES, INCENTIVES, INCENTIVES would be freely handed out to all sorts of producers and to all consumers. Again, without going into detail, instead of mandating car fuel standards, all consumers would given good reason to buy more fuel efficient vehicles and to drive vehicles less.

THE BIG WIDE AND DEEP SUBSTITUTION OCEAN WOULD DO ITS MAGIC: The law of substitution is so much more powerful, broad and deep than the average person can imagine. No government bureaucrat can possibly design a cap and trade system that will do what the law of substitution will do automatically. A higher fuel price will lead businesses and consumers to make trillions and trillions and trillions of decisions that will result in fuel savings. The ripple of one decision will lead to many others. For example, if just a relatively few people decide that the long commute from the country is no longer worth while, some will move to the city and others will hook up a high speed Internet service and work from home. Of the few who move to the city, some will find that they enjoy living near a mass transit station. The ripples go on and on and on.

OBESITY REDUCED! At least one economist has done a study that indicates that obesity is reduced as a result of higher fuel taxes. Of course, not everyone will do more walking if fuel taxes increase but some people will.

Tax preparation simplification. Yeah, we have heard this one before but it is time to do the drill one more time. Many of the simplifications in 1986 held for several years. The public deserves a simpler system.

The side issues are interesting but the main point is powerful; a revenue neutral shift in the tax rates would cut carbon emissions while giving the economy a boost.

Sure, if you try hard enough, you can find a few examples of people who would be hurt by the higher taxes but these would be few and far between. Indeed, I believe the results would be very good for the great majority of all people. In terms of Pareto Optimality, people on both sides of the issue would win. Wow, a trade where both sides win! That is the way trades generally work!


48 days is an eternity for any investor who is watching his account too closely. The coming elections are all important to the powers that be. There is the risk that proposals will be made, such as adding middle class children to government health insurance rolls, solely for political reasons. I believe incumbents in the congress need to perform or a "dump them all movement" could materialize.

There is art and science to confusing the public. Not a day passes without my hearing at least a dozen false statements that have been "sold to the public". Examples of false statements I have heard recently, "The middle class pays the bulk of the taxes", "Divorce rates are going out the roof.", "The number of Christians in the world is falling rapidly", and "there are 47 million Americans who cannot afford health insurance".

The facts are: 1) the rich pay the majority of the taxes, indeed, the top 25% of American earners pay 83.9% of all the income taxes collected; 2) divorce rates peaked in 1975; 3) Muslims bear more children on average than do Christians who bear more children than to the non-religious and the majority of children adopt the faith of their parents, as a result, the number of Christians is growing steadily but not as fast as the number of Muslims; 4) a) of the 47 million Americans who do not carry health insurance, many can afford such coverage but they are young, healthy and relatively well off, they choose not to pay for insurance but to opt for "self insurance", b) many others are healthy people who qualify for Medicaid but do not bother to apply for it until they get sick c) others are temporarily out of work. I will be the first to say that the health insurance laws need overhaul but the recent push to enroll middle class children in government insurance programs is nothing but politics. The fact is that the number of children who are not covered by insurance has gone down dramatically during the Bush Presidency. Listening to the rhetoric, the public is lead to believe that throwing 35 billion dollars at a 5 billion dollar program is the solution to the health care mess. In fact, throwing dollars at this one area would only add to the mess. Comprehensive reform is needed.

BUY BUY BUY AND BE PATIENT PATIENT PATIENT. The markets will discount the likely outcomes long before the actual bills are passed. The next 7 weeks might be a bouncy time but, between now and next fall, the "feel good" factors will boost the market. Four hundred sixty eight house and senate seats are up for grabs. The incumbents want to retain power. Not much will happen in the congress next year but these folk have given themselves 48 days to pass the 12 budget bills required by law. The pressure is on to produce results. BUY, BUY, BUY!